Near-record growth in the custodial holdings at the Fed; ongoing angst about the dollar’s role as a reserve currency …

Central banks haven’t lost their appetite for Treasuries. At least not shorter-dated notes. John Jansen noted before yesterday’s 2-year auction “the central banks love that sector [of the curve].” And the auction result certainly didn’t give him cause to backtrack. Indirect bids — a proxy for central banks — snapped up close to 70% of the auction. Jansen again:
The Treasury sold $ 40 billion 2 year notes today and the bidding interest from central banks was frantic. The indirect category of bidding ( which the street holds is a proxy for central bank interest) took 68 percent of the total. That leaves about $ 13 billion for the rest of us.

Central banks also seem increasingly interested in five year notes. Indirect bids at today’s five year auction were quite high as well.*

Strong central bank demand for Treasuries shouldn’t be a real surprise. Reserve growth picked up in May: look at Korea, Taiwan, Russia and Hong Kong. There are even rumblings – based on the data that the PBoC puts out — that Chinese reserve growth picked up as well. The rise in reserve growth fits a long-standing pattern: emerging markets tend to add more to their reserves — and specifically their dollar reserves — when the euro is rising against the dollar. A fall in the dollar against the euro often indicates general pressure for the dollar to depreciate — pressure that some central banks resist (Supporting charts can be found at the end of a memo on the dollar that I wrote for the Council’s Center for Preventative Action).

And the Fed’s custodial holdings (securities that the New York Fed holds on behalf of foreign central banks) have been growing at a smart clip. Recent talk about a shift away from a dollar reserves by a few key countries actually coincided with a surge in the Fed’s custodial holdings. Over the last 13 weeks of data, central banks added $160 billion to their custodial accounts, with Treasuries accounting for all the increase.

$160 billion a quarter is $640 billion annualized — a pace that if sustained would be a record. Of course, $640 billion in central bank purchases of Treasuries would still fall well short of meeting the US Treasuries financing need. The math only works if Americans also buy a lot of Treasuries. That is a change.

Still, most emerging economies seem to have concluded that the risks associated with holding too few dollar reserves exceed the risks of holding too many dollars. That doesn’t seem to have changed.

China may be in a different position, but it likely will find that scaling back its dollar exposure is hard so long as it wants to maintain a dollar peg …

The rise in the Fed’s custodial holdings isn’t a perfect indicator of dollar reserve growth. If a reserve manager pulls dollars out of a bank and invests the proceeds in Treasuries, that can show up as a rise in the Fed’s custodial holdings. A reserve manager that shifts a Treasury bond from a private custodian to the Fed can produce a similar result. Both no doubt happened last fall and early this winter. Conversely, central banks can — and do — hold Treasuries with private custodians. From mid 2005 to mid 2006 the rise in central banks holdings of Treasuries (according to the survey) exceeded the rise in the Fed’s custodial holdings.

But the Fed’s data is the best high-frequency data we have got. And if central banks reserves are up and the Fed’s custodial holdings are up, Occam’s razor suggests that central banks are adding to their dollar reserves.

That isn’t to say all is well so long as central banks are adding to their dollar reserves.

On one hand, there is a risk that a return to excessive reserve growth will keep the United States trade deficit from continuing to adjust. They could make it harder for exports to spur US growth. A depreciating dollar is once again producing a depreciating RMB.

And on the other, central bank reserve managers are a lot more comfortable holding short-term US notes than longer-term US notes. There consequently is a potentially a gap between what central bank reserve managers want to buy and what the US wants to issue. That is a more subtle version of the argument that central banks won’t finance the US deficit. Central banks might finance the deficit but not by buying the tenors the US really wants to sell.

Central banks could be clustered at the short-end of the curve because they fear that US inflation will rise — and they don’t want to be stuck with longer-term US bonds then. Or they could just worry that they will buy a bond that yields 3.5% only to see yields rise to 4.5%, producing a mark-to-market loss. Or it could just be a mechanical result of central banks aversion to the risk of any (mark-to-market or accounting) loss. More volatility means a high probability that a longer-term Treasury portfolio might lose value. That mechanically might lead some central banks to shorten the maturity of their holdings.

But there is a limit to how far central banks can go. Bills don’t produce any income, and most central banks need some income from their reserve portfolio. When the yield curve is steep, that generates pressure to hold something that has a slightly longer maturity. The two year note seems to be hitting central bank reserve managers’ sweet spot — and today’s auction suggests that central bank demand for somewhat longer tenors could be picking up as well.

UPDATE. From last Wednesday to this Wednesday, the Fed’s custodial holdings were pretty close to flat (looking at the data from the end of the reporting week, not the change in the weekly averages). From May 27 to June 24 (a four week period), the custodial holdings rose by about $30 billion, with an increase in Treasuries of a bit less than $40 billion and a fall in Agencies of a bit less than $10 billion. That is a solid increase, but a much slower increase than in May — when an uptick in capital flows to the emerging world pushed up reserve growth.

* One caveat: the recent rise in indirect bidding may be — in part — a function of changes in auction rules. “Guaranteed bid arrangements” through the primary dealers have been eliminated. See Jansen (and ultimately the reporting by Min Zeng of Dow Jones)

42 Comments

The Fed told us today basically that we are having a Goldilocks Recovery. Not too hot, not too cold…just right.

2 minutes after the news release the 10 and 30 yearlings weakened 10bps.

So lets complete our fiscal math. If the CBs keep going at an annual clip of 640B, the Fed keeps doing 300B and the deficit is 1.8T, that leaves $860B for us. This year.

Also, seems that some of the buying we see from CBs may be preceeded by selling T-Bills. And maybe they don’t keep bills as custodial holdings at the Fed? Makes me wonder if this is all really new funding, or maybe some jiggling of average maturities by the CBs.

Posted by yodaJune 24, 2009 at 7:48 pm

until RSI is above 50 for $USD and $USB, it is crazy to believe sovereign or anyone’s confidence in USA gov and FED is back.

and goldilock with toxic waste still on banks balance sheet? and pick up in credit card company’s charge off?

Posted by Glen MJune 24, 2009 at 8:58 pm

Brad:”On one hand, there is a risk that a return to excessive reserve growth will keep the United States trade deficit from continuing to adjust. They could make it harder for exports to spur US growth. A depreciating dollar is once again producing a depreciating RMB.”

http://www.voxeu.org/index.php?q=node/3666
“The main counterpart to the overvalued dollar is the undervaluation of the Chinese renminbi, along with a few of the smaller Asian currencies. We are somewhat nervous because our estimate (based on the figure of RMB 4.88 to the dollar) of Chinese undervaluation is even larger than it was a year ago (RMB 5.81 to the dollar), despite the fact that the RMB rode the dollar up by 14% in effective terms in the intervening year.”

Posted by DJCJune 24, 2009 at 9:46 pm

Despite the current campaign to lessen the dollar’s role, analysts note that there has not yet been a major push by foreign governments or private investors to shed it. In fact, over the course of the financial crisis, the dollar — which had been on a downward trajectory for months — has actually strengthened against major currencies, including its closest rival, the euro.

That is partly because even nations like China — with the world’s largest dollar-denominated reserves, at close to $2 trillion worth — have shied away from dumping the dollar, fearing it could trigger a global run that would severely damage the value of their holdings. Additionally, other mighty currencies like the euro have lost their chance to claim the dollar’s crown because their issuing nations are in even worse economic shape than the United States. In times of crisis, the dollar, as well as dollar-denominated U.S. Treasury bonds, are still seen as safe havens.

“The U.S. had to screw something up to lose the dominance of the dollar, and you could argue that the U.S. starting a global financial crisis is a pretty big screw-up,” said C. Fred Bergsten, director of the Peterson Institute of International Economics and a top economic official during the Carter administration.

talk about diversify out of usd and usd denominated trash. any question?

Posted by guestJune 24, 2009 at 11:07 pm

It is noticeable that the economy is still living in a cybernetic world, where financial engineering is prevailing. One may assume that real stabilisation will occur when real engineering will prevail,but for now let us pretend.
EIA short term outlook
Overview. Oil prices rose for the third consecutive month in May, driven in part by expectations of a global economic recovery and future increases in oil consumption. In addition, a weaker dollar and increasing financial market activity are prompting higher prices for commodities, overshadowing weak oil supply and demand fundamentals

Posted by God of FinanceJune 25, 2009 at 12:43 am

God of Finance

Earthlings, listen up. I am your God, stupid, not him, your God of Finance. I, as you know …hadn’d been with you as long; only 700 years since Emperor Kublai Khan started paying paper instead of silver money. Of course scoundrels immediately started to cheat with faked look-alikes but the punishment was sufficient to deter these devious beings to spoil my coming-out party, heard of Death-by-a-Thousand-Cuts.

I was once almost dead, chained by these little rules that they called regulations and destroyed over half of the planet by the halfling who called himself Marx. Devilish wasn’t he; the you-know-who compensated for his, Mmm, you know what by that gigantic beard. I was then freed by that odd couple, Ron and Margaret; they each had their own wife and husband, I thought; but it was she, I believe, said “can do business”. Sorry to say it, but it is true that I am a fickle god and there had been many upheavals, not only in the land of my origin in the Yuan empire but also in much of the new European ones like that has-been Holy Roman province of the Tulip fields, the kill-all-the-Reds British South Seas, the new-paradigm swamps of the French Mississippi, the Versailles victimized Weimar, and of course the blindly blissful 1929 New York. Well, admit it; you are living in one!

Contrary to common belief, I do not usually strike a touch of anger unannounced. There were some unchained souls like M. Roubini, Shiller, and even this halfling Krugman; all gentlemen of immense intelligence, and almost my ego, surely would have spoiled my next party, had it not been for your, say, l’armour d’argent. Ah, the causes. It was actually quit simple; I naturally live in your economy, which usually has a productive side, and a financial side. Like, some work and put food on the table, and others count it. So long as the two are balanced, the financial side supports the productive side and the productive side supports the financial side, which creates the wealth, you know, things like that shining suite on your chest, the sleek iPod in your pocket, and even that brothel that you frequent.

But unlike me, who is divine, you are only human. Every so often, especially with Ron and Margaret in business, you mistake the shenanigans as “Financial Innovation” – something like “efficient finance” actually produces real wealth by counting it many times. It happens like this. Production gets you feeling rich; you then juice it up by borrowing. Being low in intelligence, you are carried away by borrowing so much, until that is, there is nowhere to borrow, only debts to repay, if you can repay at all. Your losses are also piling up at the same time.

Like all gods, I cannot have mercy on the greedy. I will have to punish you hard until you are pants down. I remember in 1929, those who feared me jumped and quite a few pretty widows were produced, tempting even for a divine being like me. This year, there hadn’t been a lot of self-killing, only that little puddle of French red, but still it wasn’t fun. The thing is, if you are illusory thinking you all can get ahead by counting money, instead of producing it, you will be very sorry indeed. Like this year, your economy is really lopsided; so many counting, so few producing, and all are greedy.

It looks like, as usual, nothing is learned yet. Your weatherman in many a fine season, he was a bean counter, wasn’t he, is telling you that great for your taxes, you will be on it again; it is all very predictable. What is going to happen is just going to be the same old game of the same people, who are intoxicated with the same old drug, pushing around the same amount of real money and each taking a same amount of little cut and then pushes it to the next stop. After enough of that go-around, you know there won’t be any cuts left but for the one on your tummy, almost sounds samiliar. Oh really, it is not even the same amount of real money, remember you will have to repay your debts. When you are sorry in a few more years, don’t tell me I haven’t told you so.

Posted by kaanJune 25, 2009 at 3:30 am

Both FED and ECB pumped their balance sheets beyond 2 trillion USD. They are both dead determined to keep Ponzi scheme going. So reserve growth in many countries you mentioned is just a effect of insane monetary and fiscal policies pursued by clueless politicians.
I think the causality very clear.Ponzi scheme in western world caused the global imbalances and Chinese mandarins happily obliged.

Posted by locococoJune 25, 2009 at 6:31 am

Nice memo, tho domestic outflows and the robustness of the delivery mechanisms of non-existing stuff sold (if asked for) are both not mentioned anywhere as a theoretical events/trigger. Plus FX vs. TM will not necessarily equal emselves out. If gaming gets a both ways affair. As for the euro-fears, if interested in conflict prevention, I d disinflate em a bit. As you corr. identified that as an “asset”.

Posted by BOBJune 25, 2009 at 7:08 am

Chinese High-Tech Industry smashing US competitors in Africa and now, Latin America. If not for the US war on Islamic terrorism, the Chinese would be designated as the strategic threat by the Washington Consensus elites.

China’s telecom suppliers are coming to the Americas. Pursuing the same formula they’ve used to win business throughout Asia and parts of Africa (selling cheap gear in low-income countries), equipment makers Zhong Xing Telecommunication Equipment (also known as ZTE) and Huawei are now getting a foothold in countries such as Argentina, Chile, and Colombia. Says Leandro Musciano, project director at Movistar Argentina, a unit of Spain’s Telefónica: “Price is important.”

By offering deep discounts, Chinese companies are grabbing business from established telecom suppliers. Huawei, which boasts annual sales of about $18 billion, now commands 29% of the phone-company gear business in Africa, No. 2 only to Sweden’s Ericsson (ERIC), which has 30% market share. ZTE, which only began selling wireless phones in 1998, is the world’s No. 6 handset seller.

The Chinese upstarts have one advantage their established competitors lack: help from Beijing.

Huawei and ZTE benefit from the fact that the Chinese government holds stakes in dozens of local phone companies. It is not surprising that these telcos increasingly buy much of their infrastructure from homegrown companies. Financially, China’s telecom suppliers also benefit (like some struggling U.S. companies today) from tax rebates and R&D grants. But what really irks rivals are the government’s low- to no-interest “loans” that needn’t be repaid, and the deep discounts local companies get on the energy and raw materials they purchase from other Chinese companies. According to public filings, this year ZTE received a credit line from the government of nearly $15 billion. Beijing bestowed $10 billion on Huawei in 2004.

Instead of counterproductively denigrating the Chinese, the Washington Consensus elites should perhaps try cooperation with other sovereign nations in the world. Iran and China’s political system is none of the damn business of Americans period. Economic sanctions on China are counterproductive as other nations are willing to supply equilvalent products. Finally, telling other societies to change their cultures and economic systems is offensive to those people.

Posted by bsetserJune 25, 2009 at 8:41 am

DJC — I don’t see any demands for China to change its culture or that matter much of its economic system — only the China-US exchange rate. And the thing about exchange rates is that they aren’t the sole property of one party; china’s exchange rate v the us is the us’s exchange rate v china ….

moreover, the huge accumulation of china’s foreign assets associated with the current exchange rate means that china increasingly is — w/o necessarily intending to — changing other countries economic systems through the scale of its inflows.

Posted by jonathanJune 25, 2009 at 9:47 am

Two quick points. First, congrats on a rarely seen appropriate use of Occam’s Razor! Second, so much ink is spilled on this subject … don’t these people read your posts? It’s not like your work is secret.

Posted by DJC.June 25, 2009 at 10:45 am

Brad — I don’t see any demands for China to change its culture or that matter much of its economic system — only the China-US exchange rate. And the thing about exchange rates is that they aren’t the sole property of one party; china’s exchange rate v the us is the us’s exchange rate v china ….

DJC – The Obama Administration is on record today criticizing the Chinese government of blocking “pornography sites”. This is clear interference in the internal legal affairs of another sovereign nation.

In order to rectify the 7 to 1 wage scale differential between the US and China for skilled engineers, the US Dollar would have to be devaluated to the intrinsic value of toilet paper. Realistically this isn’t possible. US multi-national corporations are primarily responsible for outsourcing domestic US production to China, Mexico, India, and every other 3rd world developing nation. The Chinese have become the politically correct scapegoat for US multi-national corporation outsourcing strategies.

Posted by Glen MJune 25, 2009 at 11:11 am

DJC,

How do you express your frustration with your government (assuming you are from China), for their continuing purchases of US toilet paper (treasuries)?

Posted by gmakJune 25, 2009 at 11:33 am

Ummmm. Brad, are you aware that Treasury has changed the makeup of the “indirect buyers” so that it is near impossible to tell who is in that category at the present time? It is not necessarily the CBs. FWIW.

Posted by DJC.June 25, 2009 at 12:09 pm

Glen M – How do you express your frustration with your government (assuming you are from China), for their continuing purchases of US toilet paper (treasuries)?

DJC: The petro-dollar backed US reserve currency literally has the rest of the world up the barrel. Under US Dollar hegemony, the rest of the world gets to work for free and the Federal Reserve gets to print those dollars for free. The US Dollar is de facto backed by the Gulf Arab oil reserves under US military protection. At some point in the not too distant future, the rest of the world will tire of this nonsense. The Chinese, Russians and Brazilians will trade with each other and for oil in their own currencies without the US Dollar.

Posted by FollowTheMoneyJune 25, 2009 at 1:13 pm

DJC-

In 10-20 years if we dont trade oil in dollars, lets hope they trade in a global currency (basket). Oil denominated in solely RMB, Reals or Rubles is not best interest of the world.
Why is it DJC that you are so against the current structure? Do you really want a new world power? Are freedoms of the west not more of value than those in Russia/China? Imagine the lifestyle in china/russia, I have not lived in either country but have heard stories. I don’t we realize how could we have it here in the United States to comparison of other regions. We should be grateful.

A bit off topic, i dont like todays testimony. i really admire bernanke, but congress vs. the fed is just too much. How is the Fed going to win oversight with the uproar in the house/senate?

Posted by bsetserJune 25, 2009 at 2:23 pm

gmak — perhaps. i thought indirect bids were always only loosely correlated with central bank buying (and see the * about some auction changes that seem to have the effect of increasing indirect bids generally).

that said, the fed’s custodial holdings are clearly from central banks – and they are going up.

djc — if MNCs didn’t make money outsourcing, i assume they wouldn’t do it — and if china’s exchange rate adjusted, MNCs would have different incentives.

Posted by DJC.June 25, 2009 at 2:25 pm

Followthe money: Why is it DJC that you are so against the current structure? Do you really want a new world power? Are freedoms of the west not more of value than those in Russia/China?

DJC: The multi-polar world order that eliminates Western hegemony is necessary and just. Was the sovereignty of Iraq respected? The energy reserves of Iraq don’t belong to Halliburton or Exxon-Mobil; it belongs to the Iraqi people. There isn’t any freedom for the Iraqi people under a puppet government. Freedom doesn’t come from the barrel of a M-1 tank or B-1 Aircraft bomb. Please leave the rest of the world alone to live their lives in peace.

Posted by DJC.June 25, 2009 at 2:37 pm

Brad – if MNCs didn’t make money outsourcing, i assume they wouldn’t do it — and if china’s exchange rate adjusted, MNCs would have different incentives.

DJC – Why is it China’s fault that US multi-nationals outsource everything? The US government could easily impose import taxes or other restrictions. The US blatantly imposes a 50% import tariff on Japanese trucks. The result of the tariff is that Toyota builds its pickup trucks in the United States.

If the Chinese were to revaluate the yuan versus the US Dollar, made in China exports would also be adversely impacted in other global markets.

Posted by FollowTheMoneyJune 25, 2009 at 3:10 pm

@ DJC

how do you expect corporations to maximize shareholder value year over year w/out globalization?

Posted by KinkojiroJune 25, 2009 at 6:12 pm

Brad: It is not surprising that the central banks are crowding into the short end of the market. For the Chinese it is the only sensible tactic. It is not for the fear of immediate inflation, but it is to incentivize the Fed/Administration not to debase the currency in order to generate inflation to do the work of equalising unit labour costs.

Effectively the US now has a revolving credit facility with the Chinese. Were the administration to try to generate some inflation or other tactics to force a currency move, the Chinese can credibly threaten a refinancing strike.

The move you have documented in the last 18months away from Agencies into short dated Treasuries can be viewed as a move to enforce this strategy (as can stockpiling vast amounts of commodities).

FED is determined to blow equity, real estate, and commodity bubble, no stop in sight.

Posted by yodaJune 25, 2009 at 7:52 pm

huh, central banks crowd into short-end of the market to keep FED from debasing currency? are they delusional or may be you? look at “13-WEEK TREASURY BILL (^IRX)” going down and FED just printing out more cheap dollar or T-BILL. the strategy is not working. these CBs is pushed to corner making nothing with debasing dollar and T-BILL by FED.

Posted by YingJune 26, 2009 at 12:01 am

who are the winners of currency derivatives? Why do they win all the time as if they control the direction of exchange rate? At least Chinese government don’t speculate the exchange rate, nor do they extract money out of both domestic and multinational industries.

Posted by --AndrewJune 26, 2009 at 3:34 am

“DJC – Why is it China’s fault that US multi-nationals outsource everything? The US government could easily impose import taxes or other restrictions. The US blatantly imposes a 50% import tariff on Japanese trucks. The result of the tariff is that Toyota builds its pickup trucks in the United States.

If the Chinese were to revaluate the yuan versus the US Dollar, made in China exports would also be adversely impacted in other global markets.”

**********************

DJC, if the U.S. (or other WTO / G20 countries for that matter) started playing by Chinese rules and with the same level of moral indignation we would probably have the mother of all trade wars starting.

Trade relations are not about a particular national or world view of what is “Fair”, they are about getting what you need economically and not getting taken advantage of horribly. I’ve always understood them to be like the classic prisoner’s dilemma scenario of cooperate with the other prisoner and you both get what you need or betray (or get betrayed) and get an advantage (or get taken advantage of) and probably never be trusted again (or trust the betrayer). Which is IMHO as reasonable and pragmatic approximation of fair as you are likely to get in this world, particularly one where there are no official judge/economic policeman to call foul or can enforce the ruling without assistance.

Many of the Chinese multinationals are owned by the Chinese government, such as the aforementioned Sinopec, it would probably be politically difficult for them to outsource or not buy domestic Chinese products regardless of the economics. The level of government ownership and control is also causing many pause when these Chinese multinationals try to buy other corporations. And yet, I seem to recall that there were/are many restrictions on similar corporate purchases of domestic Chinese companies.

I suspect that it will be unrealistic for Chinese policymakers to assume that Chinese trade practices and off the books trade assistance they give their exporters are not going to get a lot of scrutiny in the near future by many countries (India is already on record in this regard). They are also not going to be the only ones being given this treatment, as evidenced by the recent international furor over the U.S. Congress’ “buy American” push.

China will soon be the number two world economy (with number one currently looking like it’s falling fast), it probably should get used to the naturally higher level of world scrutiny and criticism that comes with the title. As both Brad and Michael Pettis have recently implied in their posts, China is of the economic size now that it’s actions economically have a large effect others whether it intends it so or not.

Out of curiosity, in your opinion, what economic stage/size should China get to before it is so economically dominant that it no longer needs the emerging economy-style import/export protections, corporate ownership restrictions, a pegged currency and/or a huge currency reserve to avoid getting economically taken advantage of? In addition, if something one country economically does starts to majorly affect one or more other countries, at what point does it cease being primarily an “internal affair” of the first country and they should start to listen to what the others have to say and try to work out a mutual compromise? Or do you think that inter-country trade/economic relations are doomed to always be dog-eat-dog with every country taking the most advantage it can, of anyone it can, because it can?

Posted by MinzuJune 26, 2009 at 4:03 am

DJC:

“Instead of counterproductively denigrating the Chinese, the Washington Consensus elites should perhaps try cooperation with other sovereign nations in the world. Iran and China’s political system is none of the damn business of Americans period. Economic sanctions on China are counterproductive as other nations are willing to supply equilvalent products. Finally, telling other societies to change their cultures and economic systems is offensive to those people.”

Minzu does not approve and regards your comments as counterproductive to the Cause

Posted by Indian InvestorJune 26, 2009 at 4:34 am

DJC has the most accurate view of the US standpoint on the currency system. Besides, having the US dollar as the primary reserve currency didn’t help Americans at all; it only helped owners of US banks, US oil companies and US weapons contractors.
It’s hard to see why everybody needs to gang up on DJC and criticize him, especially when he’s mostly quoting other sources.

Posted by MinzuJune 26, 2009 at 4:56 am

Kinkojiro,

‘Effectively the US now has a revolving credit facility with the Chinese. Were the administration to try to generate some inflation or other tactics to force a currency move, the Chinese can credibly threaten a refinancing strike.’

You seem to have a point here but just go through a scenario: China tries to move an extra third of its reserves into say, 1/3 JPY and 2/3 EUR as its T bills mature and it does so without announcing a target level of diversification (unlike vague statements about SDRs etc). What would happen to JPY and EUR if the market got wind of this (it would take no more than a day). That would would be construed as hostile behavior.

No I think that China’s leverage is not that it can ask its money back, but that it can refuse to accommodate the US gvt need for low interest rates in the longer maturities. The housing recovery needs it and the US needs a housing recovery. But even there, China cannot push too hard since China’s return to very high growth depends amongst others on US consumption capacity, and that depends on … etc

Posted by TomJune 26, 2009 at 12:14 pm

Just a hunch, but I suspect the Fed’s figures on custody accounts are overestimating the accumulation of Treasuries by foreign central banks. If you look at Treasury’s numbers (which I think are more accurate but less timely), they accumulated only $5 billion in April.

The anecdotal reports of big appetites could be partly explained by a shift to longer maturities as spreads widen in reaction to the Fed’s liquidity injections. According to to the Treasury data, foreign central banks overall in April shifted about $12 billion from bills (up to 1 year) into bonds and notes (more than 1 year).

Posted by --AndrewJune 26, 2009 at 12:47 pm

Sorry Indian Investor, the intent was not to pick on DJC (at least for me) but was to elicit some more details on his views. Unfortunately things are highly stressed economically and passions on all sides are running high. Strong viewpoints tend to elicit strong responses as people defend their positions.

Glen M: How do you express your frustration with your government (assuming you are from China), for their continuing purchases of US toilet paper (treasuries)?

As far as I know, he isn’t. He’s Malaysian Chinese, and a lot of the anti-Westernism (which I personally find ludicrous) that he espouses I’ve found is much more common among Malaysian Chinese than among Chinese from China. I think his views are very strongly influenced by Malaysian politics, whereas mine are very strongly influenced by American politics.

Then again the Chinese from China I know are people I’ve met in financial services and working for multinationals.

One reason I find it necessary to argue with him is that otherwise people tend to think that what he says or what I say are somehow representative of what Chinese people think, and if you find large numbers of Chinese, then you figure out that Chinese people disagree about things. The fact that I find his views ludicrous when they are not dangerous just emphasized that point.

Having said that, I do think that my largely pro-Western views are more common among policy makers in China than his anti-Western ones are, if for no other reason that policy makers in China are more likely to have spent large amounts of time in the United States and working for MNC’s than they are having spent large amounts of time in Malaysia and trying to overthrow hedge funds.

DJC: But what really irks rivals are the government’s low- to no-interest “loans” that needn’t be repaid, and the deep discounts local companies get on the energy and raw materials they purchase from other Chinese companies.

This is massively incorrect in the case of Huawei. Huawei is not a state owned enterprise, and does not have access to the type of credit that SOE’s have. It has gotten one loan from a policy banks, but that loan is expected to be repaid, as the Chinese government is not in the business of funding unprofitable companies. Chinese companies are expected to make a profit, since the government needs profitable companies to fund its pension and social services costs.

This is why Huawei has been so successful. If the Huawei was getting subsidies from the government, there would be no particularly reason for it to make a profit.

–Andrew: Many of the Chinese multinationals are owned by the Chinese government, such as the aforementioned Sinopec, it would probably be politically difficult for them to outsource or not buy domestic Chinese products regardless of the economics.

It’s actually not, and Sinopec is a good example of how economics trumped politics. Last year, price controls were causing huge oil shortages in China, while Sinopec and the other Chinese oil companies were happily selling their oil overseas and rather than selling their oil domestically and ending up with a loss.

Why didn’t the Chinese government just order Sinopec to sell oil domestically? First, it didn’t have the legal authority to do this. China has used the legal system to insulate SOE management from political considerations. Second, it’s not in the Chinese government’s interest to have Sinopec lose money. If the Chinese government forces Sinopec to sell oil at a loss, then local shareholders of Sinopec would start screaming as would the pension agencies and state owners of the SOE’s which would lose large amounts of money.

–Andrew: The level of government ownership and control is also causing many pause when these Chinese multinationals try to buy other corporations.

Invariably what happens is that you have a competing Western company that uses every trick in the book to make the Chinese multinational look bad. In situations were the Chinese multinational can made a deal with Western companies, no one cares.

–Andrew: China will soon be the number two world economy (with number one currently looking like it’s falling fast), it probably should get used to the naturally higher level of world scrutiny and criticism that comes with the title.

Maybe, but you can get rid of the scrutiny by paying off the right people. In every case that I’ve seen where there are a lot of people screaming against a China deal, there is someone behind it that stood to lose a lot of money if the deal had gone through.

You figure out what companies and interest groups can make trouble for you, and then you buy them out before they start screaming in front of the news. If CNOOC and found a way of partnering with Cheveron rather than competing with it over Unocal, you would not have seen people screaming as much, because Cheveron’s lobbyists and PR people would be going back and forth shouting about how good the deal is rather than trying to talking about how it is the end of the world.

It’s all business. Mergers and acquisitions are the law of the jungle, where you use every PR and lobbying tool that you can. But people in the field realize that “it’s just business.” CNOOC and Cheveron were signing some joint ventures at the same time they were trying to kill each other in the media.

Indian Investor: DJC has the most accurate view of the US standpoint on the currency system.

Personally, I think he is dangerously misinformed about how the system works. Fortunately, I don’t think too many people in China in any policy making role have similar opinions.

Indian Investor: Besides, having the US dollar as the primary reserve currency didn’t help Americans at all; it only helped owners of US banks, US oil companies and US weapons contractors.

You do realize that a lot of people work for US banks, US oil companies, and US weapons contractors.

If the situation is *really* mass versus elite, then you’ve won. That’s not the real situation in the United States, and enough “ordinary Americans” benefit from Chinese trade and US political and military dominance that you aren’t going to get anywhere trying to do a populist revolution.

The American public really does benefit from US global dominance, which is why I think it is stupid for Chinese to challenge that dominance.

Indian Investor: It’s hard to see why everybody needs to gang up on DJC and criticize him, especially when he’s mostly quoting other sources.

Well because I think he is wrong and dangerously wrong, and I think his economic and political ideas would destroy China. Fortunately, they aren’t that common among Chinese policy makers.

DJC: Finally, telling other societies to change their cultures and economic systems is offensive to those people.

This is total and utter garbage. China absolutely needs to change and keep changing its culture, its political system, and its economic system. If you stop changing, then you die.

Personally, I welcome ideas and suggestions on how to change and I think that harsh criticism on how Chinese people do things is a good idea. Foreigners can often come up with better ideas and criticism because they are looking at things from the outside.

If you go beyond criticism to *imposing* a new system, then you start having problems.

One of the advantages of shortening duration as central banks have done, is that the selling event can be achieved more easily by letting maturity take its course. Now, it is indeed the case that the structure of US outstanding debt has now reached a 40/60 split between short and long duration, yes? I believe it’s the case that 40% of US outstanding debt matures within the next 24 months. That makes “selling” alot easier and less disruptive if you are a CB holding lots of those USTs. Also, it (could) function as powerful form of political leverage.

Kind of puts a potential twist on the Sudden Stop phenomenon. There no longer needs to be a mass dumping of USTs to create a funding crisis. CBs just need to stop buying, or in this case, elect to no roll over.

Of course, we already have a funding crisis and a funding shortfall. There is simply not enough capital in the world to buy our MBS and USTs, so the FED is monetizing both. Sure, it’s advertised as an interest-rate influencing operation, but it’s a monetization of the shortfall, of the deficit.

And to that extent, the US govt is already engaged in a form of debt repudiation as it willfully explodes the supply of UST, and monetizes the shortfall, knowing that this supply is now no longer backed fully by tax revenues or savings.

It’s only behaviorism and faith, not anything structural or mechanistic, that keeps the US currently away from an Argentinian outcome.

Finally, I fully expect that the UST market will be a vehicle for other CBs to employ new QE on their own. I suspect Japan is printing fresh JPY to (buy) monetize our UST supply, and one wonders that Switzerland is now engaged in the same action. Japan certainly isn’t buying UST with trade-flow created JPY, right? USD reserve building now is more likely to come from printing and converting. And frankly, why should the FED, which is already printing to buy USTs mind if the BOJ prints to buy USTs?

Gregor: It’s only behaviorism and faith, not anything structural or mechanistic, that keeps the US currently away from an Argentinian outcome.

Economics is all about trust and faith.

There are are lots of structural factors. One is that US debts are denominated in dollars. The second structural factor is that its hard to have capital flight, if you don’t have anywhere to flee to. The third is that the US can tells the IMF what to do and not the other way around.

Posted by --AndrewJune 30, 2009 at 3:53 am

Thanks for the responses Twofish, I appreciate the view of someone who has dealt with some of these companies. I was not aware of the Sinopec insulation from political control, however I did recently read several articles and other sources citing to its (and other corps) government ownership. I suspect that, even given “the law of the jungle” business rules you cite, this fact does give some people cause for concern even if the politicians are not pulling the strings and swear they will not. This would probably be the case if Exxon or Elf was owned by the US or French governments, respectively, or any other company/government ownership relation if you ask me.

On the domestic sourcing, I can see why you say that the Chinese government could have asked them to sell their oil locally at a loss but didn’t. This is probably true enough and is genuinely laudible. It also makes sense in that it would allow the corporations to keep in business and operate without overt subsidies that may garner WTO attention. Regardless, the “buy Chinese” push they have going on probably has more of a real world effect (even on Sinopec) than a similar non-binding push by the U.S. Congress (and why to me it seems to be a dangerous move by China, even if they are only hinting that people should). Sinopec and others may have to sell their product into that market, but they will probably try to buy local if they can.

New Independent Task Force Reports

India now matters to U.S. interests in virtually every dimension. This Independent Task Force report assesses the current situation in India and the U.S.-India relationship, and suggests a new model for partnership with a rising India.

Rates of heart disease, cancer, diabetes, and other noncommunicable diseases (NCDs) in low- and middle-income countries are increasing faster than in wealthier countries. The report outlines a plan for collective action on this growing epidemic.

The authors argue that the United States has responded inadequately to the rise of Chinese power and recommend placing less strategic emphasis on the goal of integrating China into the international system and more on balancing China's rise.

Campbell evaluates the implications of the Boko Haram insurgency and recommends that the United States support Nigerian efforts to address the drivers of Boko Haram, such as poverty and corruption, and to foster stronger ties with Nigerian civil society.